Inadequate business records are not only a problem for an income tax audit by the IRS or state, the issue is critical for sales tax purposes. While the rules differ among the states, in most cases sales tax auditors can reconstruct the sales for a multi-year period based on a one or two day test period if your records are inadequate. That could prove disastrous if the test period is a particularly good day, or if your current sales are much higher than in the recent past. You could end up paying more in taxes than if you had kept good records.
You should also be aware than in most states payment of sales tax, like withholding taxes on employees, can become a personal liability of the responsible party, for example, an owner, corporate officer or stockholder. That responsibility may not be discharged in bankruptcy, either.
States are in need of revenue and are hard pressed to raise tax rates. Instead, they are becoming more aggressive at enforcing current tax laws. Sales tax is a very lucrative area; $200,000 in gross revenue may result in little or no income tax to the state. However, it could easily amount to $10,000 in sales tax.
The key to surviving a sales tax audit (actually, almost any audit) is good documentation. If your documentation is poor, the agent will reconstruct from a day's or a few days' sales or from some other criteria. And agents know that if a taxpayer's documentation is poor, their adjustment will be much larger. Moreover, courts have often held that a taxpayer with inadequate records can't challenge the state's approach since the problem was of the taxpayer's own making.
You must keep records of every sale, the amount of the sale, and the sales tax on the sale. If you give a receipt to the purchaser, you must keep a copy of the receipt or other evidence. Otherwise, you must keep a daily record of all cash and credit sales in a daybook or similar journal. Ask your accountant for help if you aren’t sure how to do this.
One state requires vendors to keep copies of:
- sales slip, invoice, receipt, contract, statement, or other memorandum of sale;
- guest check, hotel guest check, receipt from admissions such as ticket stubs, receipt from dues; and
- cash register tape and any other original sales document.
If you sell both taxable and nontaxable goods or services, you must identify which of the items you sell are subject to sales tax and which are not on the invoice or receipt. For example, a cash register tape must list each item sold with enough detail to determine whether that item is subject to sales tax. You must always separately state the amount of sales tax due on the invoice or receipt that you give your customer. All of your records must be dated and kept in good order. You must be able, through your records, to connect an exempt sale to a particular purchaser to the exemption certificate you have on file for that sale or purchaser. If you issue an exemption certificate when you make a purchase, you must maintain a record of the purchase and be able to prove the exempt use.
The burden of proving that a sale, etc. is not taxable falls upon the vendor. Thus, an exemption document from the customer is necessary to relieve the vendor of his liability for not collecting the sales tax. Or, in the case of nontaxable items, you should be able to show the reason an item or service was not taxable. Some states now have an on-line database that you can check to insure a purchaser is registered. You must still have an exemption certificate, but if the ID and name on the exemption certificate doesn't match the on-line database, you should reject the certificate. Failure to check the database could be costly.
Make sure you and your employees know which items or services are subject to tax and which are not. If your accounting or POS software can handle this task, so much the better.
Maintain a record of:
- total sales;
- taxable sales;
- purchases by the business subject to tax on which no tax was paid to the seller;
- credits (if any);
- sales and use taxes due for each locality; and
- any other special taxes due.
If you deliver goods outside of the state they will probably be exempt from tax in your home state. You must maintain records which substantiate points of delivery. The records should include receipts from delivery services, common carriers, truckers, the United States Postal Service, foreign freight forwarders and logs from company vehicles. The documents must be referenced to specific sales transactions.
In support of deductions, or claims for tax credit or refund for bad debts, returned merchandise, and cancelled sales, vendors must maintain records showing:
- date of original sale,
- name and address of purchaser,
- amount purchaser contracted to pay,
- amount on which vendor paid tax, and
- all payments or other credits applied to the account of the purchaser and the date of such payments or credits.
You should be able to reconcile your general and subsidiary books of account such as the general ledger, a sales ledger, etc. to your sales documents.
K.R. Hoffman & Co., LLC, counsels Entrepreneurs, Professionals and Select Individuals in taking control of their taxes, and businesses. Discover how we can help you overcome your tax and business challenges. For more information or to become a client, call Kenneth Hoffman at (954) 591-8290 Monday - Friday from 8:30 a.m. to 1:00 p.m. for a no cost consultation, or drop me a note.
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